While the 114th Congress has been criticized in the mainstream media for having a fairly quiet first 100-odd days on the job, meaningful bills are making their way to President Barack Obama’s desk. First came the fast January movement on a six-year TRIA reauthorization. Next up was Tenant Star. While the voluntary program was first nixed along with the Keystone XL Bill to which it was amended, Obama would ink the policy into law when it returned to his desk on April 30 as part of the Energy Efficiency Improvement Act of 2015 (H.R. 873 and S. 535).

The program, which is modeled on Energy Star, will align office tenants and landlord interests in energy efficiency initiatives, and will “save billions of dollars on energy costs in coming years and generate new American jobs in the energy efficiency field that cannot be exported,” according to a statement from Anthony Malkin, chairman, president & CEO of Empire State Realty Trust Inc. and chairman of the Real Estate Roundtable’s Sustainability Policy Advisory Committee (SPAC).

Yet two victories for the industry doesn’t mean there won’t be future hurdles. President Obama’s budget proposes capping 1031 like-kind exchanges at $1 million. While our industry understands the importance of the 1031 program, such a cap could be branded as closing a tax loophole for the rich.

“In the long run, 1031 like-kind exchanges allow more capital to flow to investment opportunities, which impacts job growth and more general economic growth,” said Kevin Hogan, president & CEO of the Investment Program Association (IPA). “The rippling effects of removing 1031 could prove to
be dramatic.”

Also on the IPA’s agenda for 2015 is maintaining the pool of accredited investors who are able to diversify their portfolios with commercial real estate. The Dodd-Frank Act requires the SEC to review the definition of accredited investors once every four years—that review has already begun. Hogan says the SEC should consider additional indicators of sophistication, like work experience, investment experience and the use of professional advice.

“Why does a $200,000 salary make you sophisticated, but a $150,000 salary doesn’t?” he asked.
The advent of crowdfunding for commercial real estate makes the accredited investor definition more important than ever.

Another finance sector concern comes from the broader implementation of Basel III’s new rules for high-volatility commercial real estate (HVCRE), according to Christina Zausner, vice president of policy and industry analysis for the Commercial Real Estate Finance Council (CREFC). Under the rules, appreciated land value does not contribute to the 15 percent equity requirement for a construction loan.

“This is a big concern,” Zausner said. “Historically, developers buy a piece of property and work toward zoning changes and other permits, which can add to the value of land. Even if they haven’t, it is customary that developers get credit for increases in land value when structuring a construction loan.”
In addition, an HVCRE loan includes significant restrictions on taking internally generated capital out of the deal at any point. Other hurdles include more regulations determining how and when a bank can reclassify an HVCRE loan to income-producing real estate (IPRE) status. These new rules make money more expensive.
“It is going to be 50 percent more costly for a bank to hold it, and some of that cost is going to trickle down to the developer,” Zausner added. “What we are hearing is that the cost of an HVCRE loan—no other factors included—is adding 40 to 80 basis points to an average construction loan.”

And don’t think you can turn to a community bank or non-bank for cheaper financing. Small banks are going to start retroactively reporting to HVCRE in January 2016, unless they are released from the requirement before then.
As for non-bank lenders, “typical economic analysis says that when you raise rates on one end of a market, they usually rise organically, though maybe not as high, in the competitive market,” Zausner said.

Pie in the Sky
Of course, federal tax reform is another area to keep an eye on when it comes to factors that could increase the cost of doing business. Back in February, chairman of the House Ways and Means Committee Paul Ryan predicted that “tax reform is a 2015 thing for sure” and said he thought “it’s got to be done by the end of summer.” To the surprise of no one, that now looks like a pie-in-the-sky scenario.

“Are we going to get tax reform this year? Obviously, we’d love it, and we are pushing for it, but given the reality of the presidential politics being in play, it is probably unlikely,” said Tom Bisacquino, president & CEO of NAIOP. In spite of the presidential rhetoric consuming most of the oxygen in the debate, Bisacquino did say that there is a lot going on quietly behind the scenes.

When asked about the possibility of moving forward with the industry-praised Marketplace Fairness Act (Internet sales tax), Bisacquino said that Republicans and Democrats alike are afraid to touch it due to the possibility of constituents falsely perceiving it as a new tax. “Nobody wins votes by proposing new taxes,” he added.

Yet at the state level there was a recent tax ruling that could reverberate into more markets in the future. Earlier this year, the Indiana Board of Tax Review ruled that a Marion County Meijer store should have been valued based on the success of its business, rather than its real estate. Steven Paul, a partner at Faegre Baker Daniels who represented Meijer in the case, successfully argued that it is appropriate for assessors to value an operating big-box retail asset based on the vacant sales price of similar properties. After all, outside of net lease transactions, big-box stores only sell when they are vacant, and Indiana defines tax value as market value in use, not highest and best use.

“If a big-box store is successful, that success is really business value—not the value of the real estate,” Paul said. “The business value is already taxed in income tax; it should not be included in the property tax, as well.”

While the assessment community in Indiana has gone to the legislature seeking a ruling against using empty stores to value ongoing retail businesses, wider adoption would place retailers in certain areas in a more profitable business environment with significantly lower property taxes.

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